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Deductions for Prepaid Property Taxes Limited to Assessed Taxes

Posted on December 28, 2017 by Matthew R. Madara

The prepayment of 2018 state and local real property taxes will be deductible on a taxpayer’s 2017 tax return if those taxes were assessed before 2018, according to the IRS.

Guidance issued by the IRS December 27 (IR-2017-210) attempts to address the confusion surrounding prepayment of state and local real property taxes for the 2018 tax year caused by limits to the deduction for state and local taxes in the Republican tax bill (P.L. 115-97). Under the bill, formerly known as the Tax Cuts and Jobs Act, the deduction is capped at $10,000.

Some commentators and state and local officials had suggested that taxpayers prepay property taxes following enactment of the law, resulting in media reports of long lines at some city and county tax offices as people attempted to lessen the effects of the new cap. But many of those waiting in line were reportedly prepaying their estimated property tax bill rather than assessed taxes.

State and local law will determine whether and when property tax is assessed, the IRS said, adding that assessment is “generally when the taxpayer becomes liable for the property tax imposed.” Two examples included in the IRS guidance illustrate whether prepayment of a taxpayer’s real property tax is deductible in the 2017 tax year.

In the first example, a local jurisdiction assesses its property tax on July 1, 2017, for the period of July 1, 2017, to June 30, 2018. An installment payment due in 2018 may be prepaid in 2017 and deducted on the taxpayer’s 2017 return, the IRS said.

The second example explains that property taxes assessed on July 1, 2018, for the period of July 1, 2018, to June 30, 2019, may be prepaid in 2017 but will not be deductible on the taxpayer’s 2017 tax return because the property tax will not be assessed until 2018.

But at least one practitioner thinks the IRS guidance is misreading the law.

“I question whether that result flows from the actual language in the law,” said Leah Robinson of Mayer Brown. “The language in the law just talks about taxes ‘paid or accrued’; it does not say ‘assessed.’” 

Robinson noted that there is a provision in the law that prevents taxpayers from taking a deduction for prepaying income taxes, but there is no similar limitation for the prepayment of real estate taxes, which has contributed to the idea that real estate taxes can be prepaid. “To the extent that taxes are paid, [section] 164 and the new reform provisions themselves do not seem to require that they actually be assessed; the provisions just talk about payment or accrual based on the taxpayer’s accounting method, which for individuals is the cash method,” she said.

The IRS’s statement that the property taxes must be assessed and paid is “not necessarily consistent with the language in the new law and in fact it’s not really consistent with prior practice, which allowed for a deduction for taxes paid but then required income inclusion of the taxes that had actually been overpaid,” Robinson said. “It’s an unusual situation in general, and what the IRS seems to be doing is making it even harder for folks to minimize their tax burden,” she said.

Robinson said that prepaying real estate taxes will benefit only taxpayers who both itemize deductions and avoid the alternative minimum tax, under which the state and local tax deduction is disallowed. So some individuals rushing to prepay may not receive a tax benefit, she said.

“There’s a lot of excitement about how great it would be to reduce federal income tax by prepaying real estate taxes, but my guess is that only some who prepay — those who itemize and are not subject to the AMT — will actually benefit from prepayment,” Robinson said.